I attach a slide from a presentation by Marc Lavoie given at Minsky Summer school in 2010 at the Levy Institute of Economics (Bard College).

There are several FINTECH innovations which are bringing about dramatic changes in the financial services business.

Block Chain and Distributed Ledgers

Payment Banks

Retail P2P Payment services

Mobile Payments

Secured Wallets

Domestic Real Time Payments and Transfers

Cross Border Near Real time Money Transfers

Block Chain and Distributed Ledgers, in my opinion, are/can be implementation of quadruple accounting principles envisioned by Morris Copeland and Hyman Minsky. Two economic agents engage in financial transactions which are recorded in distributed ledgers.

Some of the key components of distributed ledger technology are:

Peer-To-Peer Networking

Cryptography

Distributed Data Storage

In contrast with centralized ledgers, distributed ledgers store data at each node in the P2P network. So there is no need for an intermediating institution. From a payment system perspective, each node in the P2P network can be thought of as a bank. Each node will have its own ledger and balance sheet which will record assets and liabilities.

Ripple is a Cross Border money transfer solution which is based on block chain technology.

Recent rise of retail P2P payment services such as

Xoom

M-Paisa

PayTM

indicates a trend toward real time payments/money transfers domestic and international. This trend also indicates decoupling of these services from traditional deposit/lending banks. XOOM is a service provided by PAYPAL for international Money Transfers. Money transfers are within a few minutes.

In USA, there are new P2P services offered to facilitate faster near real time payments/money transfers through mobile and online interfaces.

Venmo (Paypal)

Zelle (clearXchange Network)

Square Cash

Braintree (Paypal)

There are also social media payments available now through which consumers can quickly send money using social media applications such as

Facebook (through Messanger app)

Snapcash (through SnapChat)

Apple PayCash (through imessages app)

TenCent via WeChat

Rise of payment banks such as PayTM is one such example. Reserve Bank of India has granted PayTM a payment bank status. But transfers are still between bank accounts of transacting consumers where deposits are kept. Payment Bank acts as a technology provider and acts as an intermediary.

As per the RBI guidelines, payments banks cannot lend they can only take deposits or accept payments.

The possible connection between inequality and market concentration, however, has been relatively understudied for many years—until recent years, that is, when a sheafof new studies examining the interactions between concentration, market power, and inequality began to appear.

A 2015 paper by Jonathan Baker and Steven Salop, for instance, examined the connection between inequality and market power and argued that “because the creation and exercise of market power tend to raise the return to capital, market power contributes to the development and perpetuation of inequality.” Harvard Law School’s Einer Elhauge also found that horizontal shareholding likely leads to anti-competitive price raises and has regressive effects. Daniel Crane of the University of Michigan, however, contends that the connection between antitrust and wealth inequality has been grossly oversimplified by advocates of tougher antitrust enforcement.

Asked if there was a connection between concentration and inequality, Chicago Booth professors Austan Goolsbee, Steven Kaplan, and Sam Peltzman pointed to data being inconclusive. Goolsbee said: “Probably [there is a connection]. But we don’treally know more than correlations at this point.” Kaplan said his own research “suggests that winner-take-all markets (driven by technology and scale) play a rolein inequality. However, they may not play the most important role.” And Peltzmansaid that “The timing suggests so, but there are a lot of unconnected dots in this question.”

Is rising inequality connected to monopolies, rent-seeking, and concentration, or is it a result of larger forces like globalization and technology? Can antitrust be used effectively to mitigate inequality, or is concentration a sign of greater efficiency? These questions, and others, were debated by economists and legal scholars during a panel at the recent Stigler Center conference on concentration in America.

The panel featured Peter Orszag, Vice Chairman and Managing Director of the financial advisory and asset management firm Lazard Freres; Justin Pierce, a Senior Economist at the Board of Governors of the Federal Reserve; Lina Khan, a fellow at Open Markets program at New America; Sabeel Rahman, an Assistant Professor of Law at Brooklyn Law School; Simcha Barkai, a PhD Candidate at the University of Chicago Booth School of Business; and German Gutierrez, a PhD Candidate at the New York University Stern School of Business. The panel was moderated by Matt Stoller of the Open Markets program at New America, who opened by observing that “a new kind of Brandeis School of antitrust is emerging, in terms of thinking about political economy.”

Much of the panel focused on the dramatic rise in corporate profits. A recent, much-discussed Stigler Center working paper by Simcha Barkai found that over the past 30 years, as labor’s share of output fell by 10 percent, the capital share declined even further. This finding goes against the argument that the labor share went down due to technological changes, or as Barkai put it: “We used to spend money on people, today we’re spending money on robots.”

Barkai’s paper finds no evidence to support the technological argument. “We’re spending less on all inputs. If you think of this from the perspective of a firm, this is terrific. After accounting for all of my costs—material inputs, workers, capital—I am left with a large amount of money, much more so than in the past.” What Barkai does find, however, is that profits have gone way up. From 1984 to 2014, the profit share increased from 2.5 percent of GDP to 15 percent.

“To give you a sense of how large these profits are, if you look over the past 30 years and you ask, ‘How much have profits increased?’ you can give a number in dollars. A better way to think about that is, “Per worker, how much have these dollars increased?” It’s about $14,000 per worker. That’s a really large number because, in 2014, personal median income was just over $28,000. It’s about half of personal median income,” said Barkai.

Barkai went on to say that these findings were more pronounced in industries that experienced an increase in concentration. “Those industries that have a large increase in concentration also have larger declines in the labor share,” he said. Barkai’s conclusions were echoed by a separate study that was recently published by David Autor, David Dorn, Lawrence Katz, Christina Patterson, and John Van Reenen, in which they found that higher concentration is connected to the fall in the labor share.

One way to consider the question of concentration and inequality, said Pierce, is to look at what happens to firms’ efficiency and markups as a result of a merger. In a recent paper with Bruce Blonigen, Pierce was able to utilize new techniques in order to isolate the effects of mergers in the manufacturing sector. Comparing data from factories that were acquired during mergers to similar factories that weren’t, and to factories where an acquisition has been announced but not yet completed, Pierce and Blonigen found no evidence of the standard argument that mergers benefit consumers by increasing efficiency, reducing production costs, and, in turn, lowering prices. Quite the opposite: they found evidence that mergers increase market power, allowing firms to generate higher profits by raising prices.

“What we find when we do this is that mergers on average are associated with increases in markups in a magnitude of 15 to 50 percent. When we look at the effect on productivity, we actually don’t find a statistically significant effect on productivity associated with mergers,” said Pierce.

Gutierrez, meanwhile, spoke about his 2016 paper with Thomas Philippon, in which the two found that concentrated industries with less entry and more concentration invest less. Before 2000, he explained, firms funneled about 20 cents of every dollar of surplus into investments. Since 2000, however, investments dropped by half—to 10 cents on the dollar.

Their findings, he said, rule out the argument that the drop in investments is related to control by the stock market. The data also rule out other theories, such as financial constraints, safety premiums, or globalization. “What we’re left with is competition, or lack of competition and governance,” said Gutierrez.

“What we find is that most industries have become more concentrated. That leads to a decrease in investment. It means less investment by leaders in particular, and at the industry as a whole. Some manufacturing industries have seen increased competition from China. For the U.S. in particular, we see that leaders invest more. They try and hold onto their position, but the overall effect is somewhat negative on aggregate investment in the U.S.”

How is this drop in investments connected to an increase in concentration? Gutierrez offered two hypotheses: one, that superstar firms, such as digital platforms, are more productive and are therefore capturing more market share. The second, he said, is increased regulation: “In particular, if you look at the cross section of industries, industries where regulation has increased have also tended to become more concentrated and have invested less.”

Orszag, the former head of the Office of Management and Budget and former Director of the Congressional Budget Office, co-authored a 2015 paper with former Obama economic adviser Jason Furman that explored the rise in “supernormal returns on capital” among firms that have limited competition. In the panel, he spoke about what he described as a “dramatic rise” in dispersion among firms in productivity and wages as an understudied driver of inequality.

“In general, if you look at most textbooks on economics and most discussions of public policy, firms are seen as this uninteresting thing that you have to deal with but don’t want to really get into the innards of. Why do some firms behave differently than others? Having now spent a bunch of time in the private sector, the culture in firms really is quite different. Firms do behave differently from one to another beyond just market structure. Within the same market in the same field, Firm A is not the same as Firm B, as people who work inside those firms know.”

Orszag pointed to OECD data that showed that top global firms have been largely exempted from the decline in productivity that advanced economies experienced over the last 10-15 years. “If there’s a structural explanation for that, whether it’s polarization or market structure or innovation, why is it affecting only the laggards in the industry and not those at the frontier? Secondly, why aren’t there more spillovers from the frontier firms within each sector to others? What is happening to the flow of information or the flow of technique or what have you that’s causing this broad, significant rise in productivity deltas across firms, even within the same sector?” he asked.

Orszag also suggested that contrary to media narratives that present growing gaps between CEO wages and median workers within each firm as a prominent driver of inequality, the bulk of the rise in wage gaps is happening between firms, and not within the firms themselves. Studies, he said, show a dramatic increase in between-firm wage inequality “and very little movement except at the very, very largest firms in within-firm inequality.”

Orszag added: “We don’t know exactly what’s causing this. This may be a sorting of workers. It may be sharing of rents in the form of wages for the top firms. It may be a whole variety of different things. What I do suggest is the vast majority of the discussion on income-and-wage inequality seems to just glide over this whole thing as if it doesn’t exist.”

A holistic approach to inequality and concentration

Khan, who in a recent paper with Sandeep Vaheesan explored the role of monopoly and oligopoly power in perpetuating inequality, argued that the way to understand the connection between market concentration and inequality is to take a more holistic approach.

The connection between excessive market concentration and inequality, she said, has been understudied for a long time. “We were really surprised to see that at the time, in 2014, there really wasn’t much research on this connection at all. The most comprehensive paper that we found was from 1975 by William Comanor and Robert Smiley, which found that monopoly power did in fact transfer wealth to the most affluent members of society and suggested that a more competitive economy would have more progressive redistributive effects,” said Kahn. “One way to understand why this connection between market concentration and inequality has been understudied is that the law decided that it wasn’t really important. Once we shifted from an antitrust approach that took a more holistic and multidimensional view of the effect of market power to an approach that privilege means prices, the research on these effects also took a hit.”

In their paper, Khan and Vaheesan argue that inequality not only harms efficiency, but also that firms use their market power to raise prices “above competitive levels to consumers and push prices below competitive levels for small producers.” The paper makes a case for more rigorous enforcement of antitrust laws, arguing that reinvigorating antitrust could be one possible remedy for the regressive redistributive effects of concentration and the political power of monopolies.

“I think at a very basic level, our current political economy reflects 30 years of doing antitrust in a very particular way,” said Khan, who listed several industries such as airlines, healthcare, pharmaceuticals, and telecom, where prices have risen following mergers and industry consolidation.

“New business creation and growth have been on a secular decline. It’s worth recalling that in an earlier era, owning one’s own business was a form of asset building for the middle class, a way of passing on wealth to one’s children. This is especially still true in immigrant communities, where owning your own bodega or your own dry-cleaning service is a path of upward mobility. You can imagine how markets that shut out independent businesses are also effectively closing off that path of asset building,” said Khan.

Khan went on to discuss the political implications of excessive market power and how they can further entrench inequality. “Big firms and concentrated industries enjoy a level of political power that they can use to further entrench their economic dominance. Politics is another vessel by which we see this,” she said.

Rahman, author of the book Democracy Against Domination (Oxford University Press, 2016), also advocated for a wider view of the issue. “When we’re worried about the problem of concentration, I think it goes much broader than the specific areas of mergers and firm size, although that’s a big part of it,” he said.

“When we think about the good things that we want from the economy, we want it to be dynamic, we want it to be innovative, we want it to enable mobility. These things are not natural products. They are a property of the underlying structure of firms, of labor markets, of financial markets, and of policies, including antitrust,” said Rahman, who went on to discuss two aspects of the rise in concentration: digital platforms and the “Uber-ization” of more and more economic sectors, and what he described as a “growing geographic concentration of wealth, income, and opportunity between rural and urban.”

Rahman suggested that other tools, not just antitrust, could be used to combat excessive market power—particularly when it comes to the power of digital platforms. “The way I want to frame this is as a problem of concentration and inequality that warps the structure of opportunity in our economy,” said Rahman. “You have antitrust and public utility law, corporate governance, and labor law as three parts of the larger ecosystem of law and regulation that, coming out of that Progressive era debate about power, were the three complements that together, it was hoped, would produce a high-opportunity, a high-mobility economy that was open to all.”

Since my earlier posts on this subject there has been several new studies published highlighting weakness in business investments as one of the cause of slower economic growth and lower interest rates.

Short term Thinking in Investment Decisions of Businesses and Financial Markets

When companies buyback shares and pay dividends rather than investing in new capacity, it leads to low economic growth and low aggregate demand.

Central Banks respond by cutting interest rates. Yet Businesses do not invest in new capacity.

Many studies attribute this to short term thinking dominant in corporate investment decisions. Pressures from shareholders push corporate managers to be short term oriented.

Many economists and thinkers have criticized this recently as advanced economies are suffering from anemic growth.

Larry Summers has invoked Secular Stagnation. He says one of the reason for Secular Stagnation is short term thinking.

Andy Haldane of Bank of England has criticized short term thinking as it prevents investments and causes low economic growth.

Key Terms:

Quarterly Capitalism

Secular Stagnation

Short Term Thinking

Low Economic Growth

Business Investments

Real Interest Rates

Monetary Policy

Income and Wealth Inequality

Aggregate Demand

Productive Capacity

Productivity growth

Long Term Investments

Share Buybacks

Dividends

Corporate Cash Pools

Capitalism for the Long Term

Dominic Barton

From the March 2011 Issue of HBR

The near meltdown of the financial system and the ensuing Great Recession have been, and will remain, the defining issue for the current generation of executives. Now that the worst seems to be behind us, it’s tempting to feel deep relief—and a strong desire to return to the comfort of business as usual. But that is simply not an option. In the past three years we’ve already seen a dramatic acceleration in the shifting balance of power between the developed West and the emerging East, a rise in populist politics and social stresses in a number of countries, and significant strains on global governance systems. As the fallout from the crisis continues, we’re likely to see increased geopolitical rivalries, new international security challenges, and rising tensions from trade, migration, and resource competition. For business leaders, however, the most consequential outcome of the crisis is the challenge to capitalism itself.

That challenge did not just arise in the wake of the Great Recession. Recall that trust in business hit historically low levels more than a decade ago. But the crisis and the surge in public antagonism it unleashed have exacerbated the friction between business and society. On top of anxiety about persistent problems such as rising income inequality, we now confront understandable anger over high unemployment, spiraling budget deficits, and a host of other issues. Governments feel pressure to reach ever deeper inside businesses to exert control and prevent another system-shattering event.

My goal here is not to offer yet another assessment of the actions policymakers have taken or will take as they try to help restart global growth. The audience I want to engage is my fellow business leaders. After all, much of what went awry before and after the crisis stemmed from failures of governance, decision making, and leadership within companies. These are failures we can and should address ourselves.

In an ongoing effort that started 18 months ago, I’ve met with more than 400 business and government leaders across the globe. Those conversations have reinforced my strong sense that, despite a certain amount of frustration on each side, the two groups share the belief that capitalism has been and can continue to be the greatest engine of prosperity ever devised—and that we will need it to be at the top of its job-creating, wealth-generating game in the years to come. At the same time, there is growing concern that if the fundamental issues revealed in the crisis remain unaddressed and the system fails again, the social contract between the capitalist system and the citizenry may truly rupture, with unpredictable but severely damaging results.

Most important, the dialogue has clarified for me the nature of the deep reform that I believe business must lead—nothing less than a shift from what I call quarterly capitalism to what might be referred to as long-term capitalism. (For a rough definition of “long term,” think of the time required to invest in and build a profitable new business, which McKinsey research suggests is at least five to seven years.) This shift is not just about persistently thinking and acting with a next-generation view—although that’s a key part of it. It’s about rewiring the fundamental ways we govern, manage, and lead corporations. It’s also about changing how we view business’s value and its role in society.

There are three essential elements of the shift. First, business and finance must jettison their short-term orientation and revamp incentives and structures in order to focus their organizations on the long term. Second, executives must infuse their organizations with the perspective that serving the interests of all major stakeholders—employees, suppliers, customers, creditors, communities, the environment—is not at odds with the goal of maximizing corporate value; on the contrary, it’s essential to achieving that goal. Third, public companies must cure the ills stemming from dispersed and disengaged ownership by bolstering boards’ ability to govern like owners.

When making major decisions, Asians typically think in terms of at least 10 to 15 years. In the U.S. and Europe, nearsightedness is the norm.

None of these ideas, or the specific proposals that follow, are new. What is new is the urgency of the challenge. Business leaders today face a choice: We can reform capitalism, or we can let capitalism be reformed for us, through political measures and the pressures of an angry public. The good news is that the reforms will not only increase trust in the system; they will also strengthen the system itself. They will unleash the innovation needed to tackle the world’s grand challenges, pave the way for a new era of shared prosperity, and restore public faith in business.

1. Fight the Tyranny of Short-Termism

As a Canadian who for 25 years has counseled business, public sector, and nonprofit leaders across the globe (I’ve lived in Toronto, Sydney, Seoul, Shanghai, and now London), I’ve had a privileged glimpse into different societies’ values and how leaders in various cultures think. In my view, the most striking difference between East and West is the time frame leaders consider when making major decisions. Asians typically think in terms of at least 10 to 15 years. For example, in my discussions with the South Korean president Lee Myung-bak shortly after his election in 2008, he asked us to help come up with a 60-year view of his country’s future (though we settled for producing a study called National Vision 2020.) In the U.S. and Europe, nearsightedness is the norm. I believe that having a long-term perspective is the competitive advantage of many Asian economies and businesses today.

Myopia plagues Western institutions in every sector. In business, the mania over quarterly earnings consumes extraordinary amounts of senior time and attention. Average CEO tenure has dropped from 10 to six years since 1995, even as the complexity and scale of firms have grown. In politics, democracies lurch from election to election, with candidates proffering dubious short-term panaceas while letting long-term woes in areas such as economic competitiveness, health, and education fester. Even philanthropy often exhibits a fetish for the short term and the new, with grantees expected to become self-sustaining in just a few years.

Lost in the frenzy is the notion that long-term thinking is essential for long-term success. Consider Toyota, whose journey to world-class manufacturing excellence was years in the making. Throughout the 1950s and 1960s it endured low to nonexistent sales in the U.S.—and it even stopped exporting altogether for one bleak four-year period—before finally emerging in the following decades as a global leader. Think of Hyundai, which experienced quality problems in the late 1990s but made a comeback by reengineering its cars for long-term value—a strategy exemplified by its unprecedented introduction, in 1999, of a 10-year car warranty. That radical move, viewed by some observers as a formula for disaster, helped Hyundai quadruple U.S. sales in three years and paved the way for its surprising entry into the luxury market.

To be sure, long-term perspectives can be found in the West as well. For example, in 1985, in the face of fierce Japanese competition, Intel famously decided to abandon its core business, memory chips, and focus on the then-emerging business of microprocessors. This “wrenching” decision was “nearly inconceivable” at the time, says Andy Grove, who was then the company’s president. Yet by making it, Intel emerged in a few years on top of a new multi-billion-dollar industry. Apple represents another case in point. The iPod, released in 2001, sold just 400,000 units in its first year, during which Apple’s share price fell by roughly 25%. But the board took the long view. By late 2009 the company had sold 220 million iPods—and revolutionized the music business.

It’s fair to say, however, that such stories are countercultural. In the 1970s the average holding period for U.S. equities was about seven years; now it’s more like seven months. According to a recent paper by Andrew Haldane, of the Bank of England, such churning has made markets far more volatile and produced yawning gaps between corporations’ market price and their actual value. Then there are the “hyperspeed” traders (some of whom hold stocks for only a few seconds), who now account for 70% of all U.S. equities trading, by one estimate. In response to these trends, executives must do a better job of filtering input, and should give more weight to the views of investors with a longer-term, buy-and-hold orientation.

If they don’t, short-term capital will beget short-term management through a natural chain of incentives and influence. If CEOs miss their quarterly earnings targets, some big investors agitate for their removal. As a result, CEOs and their top teams work overtime to meet those targets. The unintended upshot is that they manage for only a small portion of their firm’s value. When McKinsey’s finance experts deconstruct the value expectations embedded in share prices, we typically find that 70% to 90% of a company’s value is related to cash flows expected three or more years out. If the vast majority of most firms’ value depends on results more than three years from now, but management is preoccupied with what’s reportable three months from now, then capitalism has a problem.

Roughly 70% of all U.S. equities trading is now done by “hyperspeed” traders—some of whom hold stocks for only a few seconds.

Some rightly resist playing this game. Unilever, Coca-Cola, and Ford, to name just a few, have stopped issuing earnings guidance altogether. Google never did. IBM has created five-year road maps to encourage investors to focus more on whether it will reach its long-term earnings targets than on whether it exceeds or misses this quarter’s target by a few pennies. “I can easily make my numbers by cutting SG&A or R&D, but then we wouldn’t get the innovations we need,” IBM’s CEO, Sam Palmisano, told us recently. Mark Wiseman, executive vice president at the Canada Pension Plan Investment Board, advocates investing “for the next quarter century,” not the next quarter. And Warren Buffett has quipped that his ideal holding period is “forever.” Still, these remain admirable exceptions.

To break free of the tyranny of short-termism, we must start with those who provide capital. Taken together, pension funds, insurance companies, mutual funds, and sovereign wealth funds hold $65 trillion, or roughly 35% of the world’s financial assets. If these players focus too much attention on the short term, capitalism as a whole will, too.

In theory they shouldn’t, because the beneficiaries of these funds have an obvious interest in long-term value creation. But although today’s standard practices arose from the desire to have a defensible, measurable approach to portfolio management, they have ended up encouraging shortsightedness. Fund trustees, often advised by investment consultants, assess their money managers’ performance relative to benchmark indices and offer only short-term contracts. Those managers’ compensation is linked to the amount of assets they manage, which typically rises when short-term performance is strong. Not surprisingly, then, money managers focus on such performance—and pass this emphasis along to the companies in which they invest. And so it goes, on down the line.

Only 45% of those surveyed in the U.S. and the UK expressed trust in business. This stands in stark contrast to developing countries: For example, the figure is 61% in China, 70% in India, and 81% in Brazil.

As the stewardship advocate Simon Wong points out, under the current system pension funds deem an asset manager who returns 10% to have underperformed if the relevant benchmark index rises by 12%. Would it be unthinkable for institutional investors instead to live with absolute gains on the (perfectly healthy) order of 10%—especially if they like the approach that delivered those gains—and review performance every three or five years, instead of dropping the 10-percenter? Might these big funds set targets for the number of holdings and rates of turnover, at least within the “fundamental investing” portion of their portfolios, and more aggressively monitor those targets? More radically, might they end the practice of holding thousands of stocks and achieve the benefits of diversification with fewer than a hundred—thereby increasing their capacity to effectively engage with the businesses they own and improve long-term performance? Finally, could institutional investors beef up their internal skills and staff to better execute such an agenda? These are the kinds of questions we need to address if we want to align capital’s interests more closely with capitalism’s.

2. Serve Stakeholders, Enrich Shareholders

The second imperative for renewing capitalism is disseminating the idea that serving stakeholders is essential to maximizing corporate value. Too often these aims are presented as being in tension: You’re either a champion of shareholder value or you’re a fan of the stakeholders. This is a false choice.

The inspiration for shareholder-value maximization, an idea that took hold in the 1970s and 1980s, was reasonable: Without some overarching financial goal with which to guide and gauge a firm’s performance, critics feared, managers could divert corporate resources to serve their own interests rather than the owners’. In fact, in the absence of concrete targets, management might become an exercise in politics and stakeholder engagement an excuse for inefficiency. Although this thinking was quickly caricatured in popular culture as the doctrine of “greed is good,” and was further tarnished by some companies’ destructive practices in its name, in truth there was never any inherent tension between creating value and serving the interests of employees, suppliers, customers, creditors, communities, and the environment. Indeed, thoughtful advocates of value maximization have always insisted that it is long-term value that has to be maximized.

Capitalism’s founding philosopher voiced an even bolder aspiration. “All the members of human society stand in need of each others assistance, and are likewise exposed to mutual injuries,” Adam Smith wrote in his 1759 work, The Theory of Moral Sentiments. “The wise and virtuous man,” he added, “is at all times willing that his own private interest should be sacrificed to the public interest,” should circumstances so demand.

Smith’s insight into the profound interdependence between business and society, and how that interdependence relates to long-term value creation, still reverberates. In 2008 and again in 2010, McKinsey surveyed nearly 2,000 executives and investors; more than 75% said that environmental, social, and governance (ESG) initiatives create corporate value in the long term. Companies that bring a real stakeholder perspective into corporate strategy can generate tangible value even sooner. (See the sidebar “Who’s Getting It Right?”)

Creating direct business value, however, is not the only or even the strongest argument for taking a societal perspective. Capitalism depends on public trust for its legitimacy and its very survival. According to the Edelman public relations agency’s just-released 2011 Trust Barometer, trust in business in the U.S. and the UK (although up from mid-crisis record lows) is only in the vicinity of 45%. This stands in stark contrast to developing countries: For example, the figure is 61% in China, 70% in India, and 81% in Brazil. The picture is equally bleak for individual corporations in the Anglo-American world, “which saw their trust rankings drop again last year to near-crisis lows,” says Richard Edelman.

How can business leaders restore the public’s trust? Many Western executives find that nothing in their careers has prepared them for this new challenge. Lee Scott, Walmart’s former CEO, has been refreshingly candid about arriving in the top job with a serious blind spot. He was plenty busy minding the store, he says, and had little feel for the need to engage as a statesman with groups that expected something more from the world’s largest company. Fortunately, Scott was a fast learner, and Walmart has become a leader in environmental and health care issues.

Tomorrow’s CEOs will have to be, in Joseph Nye’s apt phrase, “tri-sector athletes”: able and experienced in business, government, and the social sector. But the pervading mind-set gets in the way of building those leadership and management muscles. “Analysts and investors are focused on the short term,” one executive told me recently. “They believe social initiatives don’t create value in the near term.” In other words, although a large majority of executives believe that social initiatives create value in the long term, they don’t act on this belief, out of fear that financial markets might frown. Getting capital more aligned with capitalism should help businesses enrich shareholders by better serving stakeholders.

3. Act Like You Own the Place

As the financial sector’s troubles vividly exposed, when ownership is broadly fragmented, no one acts like he’s in charge. Boards, as they currently operate, don’t begin to serve as a sufficient proxy. All the Devils Are Here, by Bethany McLean and Joe Nocera, describes how little awareness Merrill Lynch’s board had of the firm’s soaring exposure to subprime mortgage instruments until it was too late. “I actually don’t think risk management failed,” Larry Fink, the CEO of the investment firm BlackRock, said during a 2009 debate about the future of capitalism, sponsored by the Financial Times. “I think corporate governance failed, because…the boards didn’t ask the right questions.”

What McKinsey has learned from studying successful family-owned companies suggests a way forward: The most effective ownership structure tends to combine some exposure in the public markets (for the discipline and capital access that exposure helps provide) with a significant, committed, long-term owner. Most large public companies, however, have extremely dispersed ownership, and boards rarely perform the single-owner-proxy role. As a result, CEOs too often listen to the investors (and members of the media) who make the most noise. Unfortunately, those parties tend to be the most nearsighted ones. And so the tyranny of the short term is reinforced.

The answer is to renew corporate governance by rooting it in committed owners and by giving those owners effective mechanisms with which to influence management. We call this ownership-based governance, and it requires three things:

Just 43% of the nonexecutive directors of public companies believe they significantly influence strategy. For this to change, board members must devote much more time to their roles.

More-effective boards.

In the absence of a dominant shareholder (and many times when there is one), the board must represent a firm’s owners and serve as the agent of long-term value creation. Even among family firms, the executives of the top-performing companies wield their influence through the board. But only 43% of the nonexecutive directors of public companies believe they significantly influence strategy. For this to change, board members must devote much more time to their roles. A government-commissioned review of the governance of British banks last year recommended an enormous increase in the time required of nonexecutive directors of banks—from the current average, between 12 and 20 days annually, to between 30 and 36 days annually. What’s especially needed is an increase in the informal time board members spend with investors and executives. The nonexecutive board directors of companies owned by private equity firms spend 54 days a year, on average, attending to the company’s business, and 70% of that time consists of informal meetings and conversations. Four to five days a month obviously give a board member much greater understanding and impact than the three days a quarter (of which two may be spent in transit) devoted by the typical board member of a public company.

Boards also need much more relevant experience. Industry knowledge—which four of five nonexecutive directors of big companies lack—helps boards identify immediate opportunities and reduce risk. Contextual knowledge about the development path of an industry—for example, whether the industry is facing consolidation, disruption from new technologies, or increased regulation—is highly valuable, too. Such insight is often obtained from experience with other industries that have undergone a similar evolution.

In addition, boards need more-effective committee structures—obtainable through, for example, the establishment of a strategy committee or of dedicated committees for large business units. Directors also need the resources to allow them to form independent views on strategy, risk, and performance (perhaps by having a small analytical staff that reports only to them). This agenda implies a certain professionalization of nonexecutive directorships and a more meaningful strategic partnership between boards and top management. It may not please some executive teams accustomed to boards they can easily “manage.” But given the failures of governance to date, it is a necessary change.

More-sensible CEO pay.

An important task of governance is setting executive compensation. Although 70% of board directors say that pay should be tied more closely to performance, CEO pay is too often structured to reward a leader simply for having made it to the top, not for what he or she does once there. Meanwhile, polls show that the disconnect between pay and performance is contributing to the decline in public esteem for business.

Companies should create real risk for executives.Some experts privately suggest mandating that new executives invest a year’s salary in the company.

CEOs and other executives should be paid to act like owners. Once upon a time we thought that stock options would achieve this result, but stock-option- based compensation schemes have largely incentivized the wrong behavior. When short-dated, options lead to a focus on meeting quarterly earnings estimates; even when long-dated (those that vest after three years or more), they can reward managers for simply surfing industry- or economy-wide trends (although reviewing performance against an appropriate peer index can help minimize free rides). Moreover, few compensation schemes carry consequences for failure—something that became clear during the financial crisis, when many of the leaders of failed institutions retired as wealthy people.

There will never be a one-size-fits-all solution to this complex issue, but companies should push for change in three key areas:

• They should link compensation to the fundamental drivers of long-term value, such as innovation and efficiency, not just to share price.

• They should extend the time frame for executive evaluations—for example, using rolling three-year performance evaluations, or requiring five-year plans and tracking performance relative to plan. This would, of course, require an effective board that is engaged in strategy formation.

• They should create real downside risk for executives, perhaps by requiring them to put some skin in the game. Some experts we’ve surveyed have privately suggested mandating that new executives invest a year’s salary in the company.

Redefined shareholder “democracy.”

The huge increase in equity churn in recent decades has spawned an anomaly of governance: At any annual meeting, a large number of those voting may soon no longer be shareholders. The advent of high-frequency trading will only worsen this trend. High churn rates, short holding periods, and vote-buying practices may mean the demise of the “one share, one vote” principle of governance, at least in some circumstances. Indeed, many large, top-performing companies, such as Google, have never adhered to it. Maybe it’s time for new rules that would give greater weight to long-term owners, like the rule in some French companies that gives two votes to shares held longer than a year. Or maybe it would make sense to assign voting rights based on the average turnover of an investor’s portfolio. If we want capitalism to focus on the long term, updating our notions of shareholder democracy in such ways will soon seem less like heresy and more like common sense.

While I remain convinced that capitalism is the economic system best suited to advancing the human condition, I’m equally persuaded that it must be renewed, both to deal with the stresses and volatility ahead and to restore business’s standing as a force for good, worthy of the public’s trust. The deficiencies of the quarterly capitalism of the past few decades were not deficiencies in capitalism itself—just in that particular variant. By rebuilding capitalism for the long term, we can make it stronger, more resilient, more equitable, and better able to deliver the sustainable growth the world needs. The three imperatives outlined above can be a start along this path and, I hope, a way to launch the conversation; others will have their own ideas to add.

The kind of deep-seated, systemic changes I’m calling for can be achieved only if boards, business executives, and investors around the world take responsibility for bettering the system they lead. Such changes will not be easy; they are bound to encounter resistance, and business leaders today have more than enough to do just to keep their companies running well. We must make the effort regardless. If capitalism emerges from the crisis vibrant and renewed, future generations will thank us. But if we merely paper over the cracks and return to our precrisis views, we will not want to read what the historians of the future will write. The time to reflect—and to act—is now.

I have always been intrigued by multi-level thinking whether it is in organizations, biology, ecology, and evolutionary theory.

Plant – Division – Corporate – Industry – Macro-economy

Molecules – Organelles – Cells – Tissue – Organs – Whole body

Organism – Populations – Communities – Ecosystem – Bio-Sphere

How does human body forms from Molecules? Is it all evolutionary? or is there a role for Vitalism?

How to integrate decision making in organizations at multi levels? From Corporate level to Plant Level.

How does an Individual fits in Groups, Communities, Society, and Ecosystem?

What is the role of fractals thinking in Evolutionary Biology?

A SUMMARY OF THE PRINCIPLES OF HIERARCHY THEORY

The Hierarchy theory is a dialect of general systems theory. It has emerged as part of a movement toward a general science of complexity. Rooted in the work of economist, Herbert Simon, chemist, Ilya Prigogine, and psychologist, Jean Piaget, hierarchy theory focuses upon levels of organization and issues of scale. There is significant emphasis upon the observer in the system.

Hierarchies occur in social systems, biological structures, and in the biological taxonomies. Since scholars and laypersons use hierarchy and hierarchical concepts commonly, it would seem reasonable to have a theory of hierarchies. Hierarchy theory uses a relatively small set of principles to keep track of the complex structure and a behavior of systems with multiple levels. A set of definitions and principles follows immediately:

Hierarchy: in mathematical terms, it is a partially ordered set. In less austere terms, a hierarchy is a collection of parts with ordered asymmetric relationships inside a whole. That is to say, upper levels are above lower levels, and the relationship upwards is asymmetric with the relationships downwards.

Hierarchical levels: levels are populated by entities whose properties characterize the level in question. A given entity may belong to any number of levels, depending on the criteria used to link levels above and below. For example, an individual human being may be a member of the level i) human, ii) primate, iii) organism or iv) host of a parasite, depending on the relationship of the level in question to those above and below.

Level of organization: this type of level fits into its hierarchy by virtue of set of definitions that lock the level in question to those above and below. For example, a biological population level is an aggregate of entities from the organism level of organization, but it is only so by definition. There is no particular scale involved in the population level of organization, in that some organisms are larger than some populations, as in the case of skin parasites.

Level of observation: this type of level fits into its hierarchy by virtue of relative scaling considerations. For example, the host of a skin parasite represents the context for the population of parasites; it is a landscape, even though the host may be seen as belonging to a level of organization, organism, that is lower than the collection of parasites, a population.

The criterion for observation: when a system is observed, there are two separate considerations. One is the spatiotemporal scale at which the observations are made. The other is the criterion for observation, which defines the system in the foreground away from all the rest in the background. The criterion for observation uses the types of parts and their relationships to each other to characterize the system in the foreground. If criteria for observation are linked together in an asymmetric fashion, then the criteria lead to levels of organization. Otherwise, criteria for observation merely generate isolated classes.

The ordering of levels: there are several criteria whereby other levels reside above lower levels. These criteria often run in parallel, but sometimes only one or a few of them apply. Upper levels are above lower levels by virtue of: 1) being the context of, 2) offering constraint to, 3) behaving more slowly at a lower frequency than, 4) being populated by entities with greater integrity and higher bond strength than, and 5), containing and being made of – lower levels.

Nested and non-nested hierarchies: nested hierarchies involve levels which consist of, and contain, lower levels. Non-nested hierarchies are more general in that the requirement of containment of lower levels is relaxed. For example, an army consists of a collection of soldiers and is made up of them. Thus an army is a nested hierarchy. On the other hand, the general at the top of a military command does not consist of his soldiers and so the military command is a non-nested hierarchy with regard to the soldiers in the army. Pecking orders and a food chains are also non-nested hierarchies.

Duality in hierarchies: the dualism in hierarchies appears to come from a set of complementarities that line up with: observer-observed, process-structure, rate-dependent versus rate-independent, and part-whole. Arthur Koestler in his “Ghost in The Machine” referred to the notion of holon, which means an entity in a hierarchy that is at once a whole and at the same time a part. Thus a holon at once operates as a quasi-autonomous whole that integrates its parts, while working to integrate itself into an upper level purpose or role. The lower level answers the question “How?” and the upper level answers the question, “So what?”

Constraint versus possibilities: when one looks at a system there are two separate reasons behind what one sees. First, it is not possible to see something if the parts of the system cannot do what is required of them to achieve the arrangement in the whole. These are the limits of physical possibility. The limits of possibility come from lower levels in the hierarchy. The second entirely separate reason for what one sees is to do with what is allowed by the upper level constraints. An example here would be that mammals have five digits. There is no physical reason for mammals having five digits on their hands and feet, because it comes not from physical limits, but from the constraints of having a mammal heritage. Any number of the digits is possible within the physical limits, but in mammals only five digits are allowed by the biological constraints. Constraints come from above, while the limits as to what is possible come from below. The concept of hierarchy becomes confused unless one makes the distinction between limits from below and limits from above. The distinction between mechanisms below and purposes above turn on the issue of constraint versus possibility. Forget the distinction, and biology becomes pointlessly confused, impossibly complicated chemistry, while chemistry becomes unwieldy physics.

Complexity and self-simplification: Howard Pattee has identified that as a system becomes more elaborately hierarchical its behavior becomes simple. The reason is that, with the emergence of intermediate levels, the lowest level entities become constrained to be far from equilibrium. As a result, the lowest level entities lose degrees of freedom and are held against the upper level constraint to give constant behavior. Deep hierarchical structure indicates elaborate organization, and deep hierarchies are often considered as complex systems by virtue of hierarchical depth.

Complexity versus complicatedness: a hierarchical structure with a large number of lowest level entities, but with simple organization, offers a low flat hierarchy that is complicated rather than complex. The behavior of structurally complicated systems is behaviorally elaborate and so complicated, whereas the behavior of deep hierarchically complex systems is simple.

Hierarchy theory is as much as anything a theory of observation. It has been significantly operationalized in ecology, but has been applied relatively infrequently outside that science. There is a negative reaction to hierarchy theory in the social sciences, by virtue of implications of rigid autocratic systems or authority. When applied in a more general fashion, even liberal and non-authoritarian systems can be described effectively in hierarchical terms. There is a politically correct set of labels that avoid the word hierarchy, but they unnecessarily introduce jargon into a field that has enough special vocabulary as it is.

A SHORT ANNOTATED BIBLIOGRAPHY OF HIERARCHY THEORY.

This bibliography is in chronological order, so that the reader can identify the early classics as opposed to the later refinements. If you must choose just one book to read, turn to the last reference in this bibliography, Ahl and Allen, 1996. Simon, H.. A. 1962. The architecture of complexity. Proceedings of the American philosophical society 106: 467-82. This is the foundation paper of hierarchy theory originating from an economist. It was a re-published in “Sciences of the Artificial” by Simon. It introduces the idea of near-decomposability. If systems were completely decomposable, then there would be no emergent whole, because the parts would exist only separately. The “near” in near-decomposable allows the upper level to emerge from the fact that the parts anre not completely separate.

Koestler, Arthur. 1967. The ghost in the machine. Macmillan, New York. This is a long hard look at human social structure in hierarchical terms. The notion of holon first occurs in this work. This is a classic work, but is easily accessible to the lay public.

Whyte, L.. L.., A. G. Wilson and D. Wilson (eds.). 1969. Hierarchical structures. American Elsevier, New York. This is a classic collection of early scholarly works by some of the founders of hierarchical thinking.

Allen, T. F. H. and T. B. Starr. 1982. Hierarchy: perspectives for ecological complexity. University Chicago Press. This book has a significant ecological component but is much more generally about hierarchical structure. It is abstract and a somewhat technical treatment but has been the foundation work for the application of hierarchy theory in ecology and complex systems theory at large.

Salthe, S. 1985. Evolving Hierarchical Systems: their structure and representation. Columbia University Press, New York. This book has a strong structural bias, in contrast to the process oriented approach of Allen and the other ecologists in this bibliography. Salthe introduces the notion of the Triadic, where there is a focus on 1) the system as both a whole above the levels below and 2) a part belonging to another level above, 3) not forgetting the level of the structure itself in between. While much biological hierarchy theory takes an anti-realist point view, or is at least reality-agnostic, wherein the ultimate reality of hierarchical arrangement is left moot, Salthe’s version of hierarchy theory is concerned with the ultimate reality of structure. The anti-realist view of structure is that it is imposed by the observer, and may or may not correspond to any ultimate reality. If structure does correspond to ultimate, external reality, we could never know that to be so. Salthe’s logic is consistent but always takes a structural and ontological position.

O’Neill, R. V., D. DeAngelis, J. Waide and T. F. H. Allen. 1986. A hierarchical concept of ecosystems. Princeton University Press. This is a distinctly ecological application of hierarchy theory, making the critical distinction between process functional ecosystem approaches as opposed to population and community relationships. It is an application of hierarchy theory to ecosystem analysis.

Allen T. F. H. and T. Hoekstra. 1992. Toward a unified ecology. Columbia University Press. This book turns on hierarchy theory, but is principally a book about ecology. It goes beyond the O’Neill et al book, in that it makes the distinction between many types of ecology (landscape, ecosystem, community, organism, population, and biomes) on the one hand, and scale of ecology on the other hand. It ends with practical applications of hierarchy theory and ecological management.

Ahl, V. and T. F. H. Allen. 1996. Hierarchy theory, a vision, vocabulary and epistemology. Columbia University Press. This slim a volume is an interdisciplinary account of a hierarchy theory, and represents the shallow end of the pool. It is the primer version of Allen and Starr 1982. It is full of graphical images to ease the reader into a hierarchical perspective. It makes the distinction between levels of organization and levels of observation. It takes a moderate anti-realist point of view, wherein there may be an external reality, but it is not relevant to the discourse. We only have access to experience, which must of necessity involve observer values and subjectivity. There are examples from a wide discussion of many disciplines. Included are examples from psychology, ecology, the law, political systems and philosophy. It makes reference to the global and technological problems facing humanity, and offers hierarchy theory as one tool in the struggle. The summary of hierarchy theory in the opening paragraphs above comes from this book.

For political reasons, if Italy or Greece decide to leave the EMU, then they are supposed to settle their debts. But they can not do that. Other countries in EMU will have to bear the burden of unpaid debts of leaving countries.

There are many lessens for other regions around the world who are contemplating monetary unions. AMU in ASEAN region is one such example. They should carefully learn from experiences of EMU as how not to do things.

From Money & Credit: Eurozone TARGET2

From Germany TARGET2 – Balance

TARGET2 is a payment system that enables the speedy and final settlement of national and cross-border payments in central bank money. An average of around 350,000 payments with a value of just under €2½ trillion are processed using TARGET2 each working day, a figure which is broadly equivalent to the size of Germany’s GDP. During a whole year, TARGET2 settles about 90 million payments with a value of about € 600,000 billion. These payment transactions can take a wide variety of forms, such as payment for a goods delivery, the purchase or sale of a security, the granting or repayment of a loan or the depositing of funds at a bank, among many others.

In addition to payments between credit institutions and from other systems (eg securities settlement systems), payments undertaken as part of the Eurosystem’s open market operations are settled via TARGET2.

If, for example, foreign funds are transferred to a bank that participates in TARGET2 via the Bundesbank, this results in a liability of the Bundesbank to this bank (such as in the form of a credit to this amount on the bank‘s current account). In return, the transaction generates a Bundesbank claim for the same sum on the sending central bank. This central bank then in turn debits the account of the originating commercial bank. This requires the originating commercial bank to have a sufficient credit balance in central bank money. Central bank credit balances are primarily provided by the Eurosystem’s monetary policy refinancing operations.

The resulting claims and liabilities generated at the national central banks by the multiple transactions over the course of a day normally do not fully balance out. Under the terms of a Eurosystem agreement, the outstanding claims and liabilities of all the national central banks participating inTARGET2 are transferred to the ECB at the end of the business day, where they are netted out. The resulting TARGET2 (net) balances hence arise from the cross-border distribution of central bank money within the Eurosystem’s decentralized structure.

The TARGET2 balance in the Bundesbank’s balance sheet is therefore mainly attributable to cross-border transactions which involve banks that participate in TARGET2 via the Bundesbank (several banks from other EU countries participate in TARGET2 via the Bundesbank in cases where their own national central banks do not participate in TARGET2). On the one hand, it is affected by credit institutions’ operations on the money and capital markets and, on the other, by transactions carried out by the non-banking sector, which generates payments via the banking system.

From TARGET2 balances

From Interpreting TARGET2 balances

The existence of a substantial German claim on the Eurosystem is well known. As shown in Graph 1, since the beginning of the financial crisis in August 2007, claims of the Deutsche Bundesbank on the Eurosystem through the TARGET2 system have gone from basically zero to more than €700 billion.1 This has led to a debate over what this accumulation means and what, if anything, should be done about it.

Interpretations of this and other TARGET2 balances fall into two camps. The first, judged a minority view by Auer (2012), is that these balances correspond to current account financing. We label this the flow interpretation. Proponents have included most prominently Sinn and Wollmershäuser (2012), whose views originally appeared as a working paper a year ago (Sinn and Wollmershäuser (2011)).2 Fahrholz and Freytag (2012) take the view that the current account imbalance will create persistent TARGET2 balances.

The second camp, including Buiter et al (2011), Mody and Bornhorst (2012), Bindseil and König (2012), and3 Cecioni and Ferrero (2012) interprets TARGET2 balances as a “capital account reversal”. That is, they see this as one symptom of a balance of payments crisis. Bindseil and König (2012) argue that the Eurosystem full allotment refinancing operations should be seen as financing the reversal of an outstanding stock of cross-border claims while the TARGET2 payments system merely records the results. We label this the stock interpretation, and trace it originally to Garber (1999).

The members of the European Economic Advisory Group (2012) take an intermediate position. They read Sinn and Wollmershäuser (2011) as arguing that Greece and Portugal financed their current account deficits in 2008 to 2010 through TARGET2, while Ireland’s TARGET2 balance was associated with a capital outflow and Spain’s TARGET2 balance financed only a quarter of its cumulated current account. Italy is identified as a case of “capital flight” in late 2011. More formally, Auer (2012) uses panel regressions to find that the TARGET2 balances track both current accounts and bank flows from Q3 2007 to Q1 2012.

Our work is most closely related to that of Auer (2012).4 Like him, we juxtapose TARGET2 balances with both current account and capital flow data, using BIS banking data. The new element in our work is that we distinguish between capital flows motivated by concerns over creditworthiness and those motivated by the low probability of redenomination.